ByRon Scherer, Staff writerMarch 15, 2011

Traders work on the floor of the New York Stock Exchange on March 14. Japan's stock market nose-dived nearly 11 percent, leading world markets sharply lower on Tuesday, March 15, as an escalating nuclear crisis threatened to compound the devastation from last week's earthquake and tsunami.

New York — After dropping sharply Tuesday morning, the stock market, by early afternoon, had regained some of its losses.

But, even with the slight improvement, the market remained lower as investors tried to figure out how the world economy would be affected by Japan’s earthquake, tsunami, and stricken nuclear power plants.

At 1:30 p.m. the Dow Jones Industrial Average was off 198.90 points, after losing 296 on the open. The selling wave extended beyond stocks, dragging commodities such as oil and gold down as well.

If the stock market were to continue to fall, it could have larger ramifications for the US economy, which had only recently shown signs of a slightly more robust recovery. The buoyant stock market has helped companies raise capital. In addition, the market’s rebound over the past two years has helped raise consumer confidence, now at its highest level since the 2008 recession. That improved confidence has resulted in better auto and retail sales as investors’ portfolios have regained some luster.

“If the decline is only a few days, it probably won’t have a significant impact on confidence,” says Lynn Franco, an economist at the Conference Board business research organization in New York. “But, if there are prolonged losses it could have a dampening effect and then it will be up to the job market to pickup the slack. It’s too soon to know.”

What makes analyzing the Japan tragedy for investors difficult is the spotty information, says Fred Dickson, chief investment strategist at D.A. Davidson & Co. in Lake Oswego, Ore. The nuclear issue, he says, goes “beyond the boundaries of anyone’s thinking, there is not a good estimate of what it will evolve into.”

“Significant contamination would make the region inhospitable to economic activity,” he writes.

Although the area of Japan affected by the crisis at the nuclear power plants accounts for only about 6 percent of the nation’s gross domestic product, it does have a lot of international connections as a supplier of auto parts and electronics.

“With the just-in-time supply chain there could be some fall-out for some technology companies and auto producers,” says Mr. Dickson. In addition, he notes the power outages may make it more difficult for large Japanese companies to plan production.

In an analysis issued on Tuesday, Nariman Behravesh, chief economist for IHS Global Insight in Lexington, Mass., estimates that the initial impact on Japan’s economy would be large but temporary. He compares the damage to the affects Hurricane Katrina had on the US in 2005 or the Kobe earthquake on Japan in 1995. Initially, he estimates, it could pare as much as a half of one percent off Japan’s gross domestic product. However, he says, as the nation begins rebuilding, the effort will boost Japan’s GDP by a similar amount next year.

But, if the nuclear emergency becomes a full-fledged catastrophe, IHS Global Insight says the negative effect on growth could be much worse.

The uncertainty is prompting Cumberland Investment Advisors, which manages $1.5 billion in assets, to sell its Japanese stock market investments.

“It is a mistake to hold when there is an uncertain and developing negative risk,” David Kotok, chief investment officer of the Vineland, N.J., money manager, writes in an online analysis Tuesday. “We have that in Japan.”

In Cumberland’s case, it’s not just Japan. Mr. Kotok, in fact, has turned negative on stocks in general, now holding the largest amount of cash since the collapse of Lehman Brothers in 2008.

Kotok is far from alone in thinking the market will be challenged in the months ahead.

Dickson, the investment strategist, anticipates the market’s pullback could last for some time as investors sort through all the economic and geo-political ramifications.

“There could be a three month period of consolidation, with some rallies and some pullbacks,” he says. “With all the uneasiness, I would not be surprised to see an 8 percent to 10 percent decline depending on what happens and continuing until the fallout becomes better known.”